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Plenty Ventured, Little Gained

On Sebastian Mallaby’s VC hagiography

The Power Law: Venture Capital and the Making of the New Future by Sebastian Mallaby. Penguin Press, 496 pages.

Venture capitalists have had a tough run in recent years. Take, for example, two new TV series parading some of their biggest failures—WeCrashed, on the disgraced co-working startup WeWork, and The Dropout, dramatizing Theranos, Elizabeth Holmes’s phony blood-testing company. The fraudulent dealings of WeWork and Theranos have become cultural touchstones in a moment where the tech industry appears more suspect than it does promising. And both brands are deeply emblematic of the shortcomings of the VC model, which rewards outlandish, half-baked business ideas by taking them to a Build-a-Bear Workshop and blowing them full of cash.

These are shortcomings that Sebastian Mallaby, a Washington Post columnist and Council on Foreign Relations fellow, earnestly hopes to dispel in his new book The Power Law. In it, Mallaby offers a defense of VC investing: an attempt to cast it as a highly skilled profession that maintains a watchful eye over Silicon Valley, tempering greed, making sweeping strategic plays, and mediating handily between market forces and eager entrepreneurs.

The VC model rewards outlandish, half-baked business ideas by taking them to a Build-a-Bear Workshop and blowing them full of cash.

Crucially, Mallaby’s attempt at a definitive history of venture capital displaces the cult of the boy-genius startup founder. For Mallaby, it isn’t the innovative, be-hoodied computer science major toiling in front of a computer screen who’s responsible for the rise of the tech industry, but the wise VC, who spots startup potential and guides tech companies to greatness. Mallaby’s revisionist history tears down the entrepreneurial mythos around Steve Jobs, Mark Zuckerberg, and Jeff Bezos, replacing these figures with the elder statesmen (and they are almost always men) behind Andreessen Horowitz, Sequoia, Accel, and Tiger Global. In many ways, it’s an attractive central premise, one that channels frustrations about the hubris of Big Tech. But in the place of the platform gods, Mallaby simply swaps in a group of dull managerial types. As far as he is concerned, the holders of the tech purse strings are the true creators of value. Armed with their keen curatorial eye, VCs operate as top-level economic planners, uncovering the future that all of us now live in.

There’s a long history of rich people throwing money at stupid projects, and VC investment is best seen as a systematized method for cutting the risks involved. In VC: An American History, the economic historian Tom Nicholas makes the point that what we know now as venture capital originated with high-risk New England whaling ventures. A whaling expedition could bring back valuable cargo (namely, whale blubber), but the trips could take several years to complete, and many ships didn’t make it back at all. If a wealthy investor gave his money to a whaling agent—comparable to today’s VCs—the agent could invest in multiple trips that he deemed promising. One of those trips would likely come back with a good haul, making all the other dud investments worthwhile.

This is the idea behind VC portfolios and the “power law” that Mallaby puts so much stock into. Today, wealthy institutional backers give money to VCs, who pool the money into a fund that in turn becomes a portfolio of companies—companies that manage to monopolize their field, skirt government regulations (labor laws, most notably), or just generally ride the tech bubble. When those companies reach an “exit,” usually by being acquired by another company or by going public as part of an IPO, the VC investors are paid back many multiples on their initial investment.

Rather than whale meat, the tale of the “Traitorous Eight” is one of the preferred origin stories of Silicon Valley. In this account, eight employees of the Northern California Shockley Semiconductor Laboratory defected in 1957 to start their own company, Fairchild Semiconductor. They were backed by a crude form of venture capital, and the founding scientists took a small equity stake in the new company, a form of employee stock ownership that would become standard in Silicon Valley. Throughout the 1960s, Fairchild Semiconductor would help give birth to Intel and AMD as well as a host of other high-tech companies. To Mallaby and other boosters of the VC model, the “liberation capital” that made Fairchild Semiconductor possible was the start of a democratization of capitalism, moving away from an economy dominated by a few large corporations to one where many smaller companies had access to capital. Mallaby is less concerned about what makes this “democratic”—which is a question of decision-making power—rather than simply a matter of getting easy cash.

To his credit, Mallaby does note the foundational role that the defense industry played in the birth of Silicon Valley. The Valley had long been a hotspot for aerospace research and the development of military equipment. In fact, as the economist Mariana Mazzucato has noted, public dollars, tax breaks, and government incentives were more important to the development of the tech industry than most like to admit. But from the 1970s on, as venture capital grew and VCs took on a more direct role in managing companies, scientists were increasingly “unshackled” from their academic labs. The flood of cash helped scientists drift away from state-funded research and toward the private sector.

Mallaby breezes through the material forces that gave rise to the VC model, choosing instead to focus on pop sociology.

Case in point: the biotech company Genentech, which Mallaby cites as a shining beacon of VC usefulness. With VC backing, Genentech played a central role in the commercialization of recombinant DNA technology for pharmaceutical purposes (most notably synthetic human insulin). Aside from being darlings of the VC world, the company is also known for paying a $200 million settlement to the University of California San Francisco over a patent dispute, aggressively lobbying Congress on health care issues, and price-gouging macular degeneration drugs.

See also Marc Andreessen, who built the Mosaic browser—which proved vitally important for the development of the internet—at a taxpayer-funded lab at the University of Illinois, only to take off with Mosaic when venture capital came to the rescue. (Of course, Andreessen himself, after posing for an ill-advised barefoot TIME magazine cover, went on to found his eponymous VC firm with Ben Horowitz.) While horror stories like WeWork and Theranos have become an easy shorthand for the excesses of the tech industry, the early successes of Genentech and Mosaic are equally concerning, if only because they show the willingness of VCs to pick at the carcasses of state-funded institutions.

Public research expropriation aside, the 1979 change to the U.S. government’s “prudent man rule” regarding pension fund investments also proved crucial to the rise of VCs. That bit of deregulation, which came about thanks in part to lobbying from investors like Lionel Pincus, allowed previously cautious pension portfolios to put their money into risky VC funds and contributed to a bonanza of VC-backed companies in the 1980s. While partying at Bohemian Grove around that same period (which may sound conspiratorial, but hear me out), the legendary VC Bill Draper successfully convinced a Reagan adviser to think about cutting the capital gains tax, which in turn helped VC funds pump more money into tech.

And yet for the most part, Mallaby breezes through the material forces that gave rise to the VC model, choosing instead to focus on pop sociology. For him, the real driving factor in Silicon Valley is what he calls “the power of networks,” an already vague assertion that becomes increasingly slippery as the book progresses. Government policy, to his mind, is infinitely less consequential than the bonds that unite the dignitaries of Silicon Valley—the “power” coming from their ability to swap names and gossip. He goes so far as to call a standard introduction that later led to a big-ticket deal an “inspired act of networking.” At worst, the power of networks is simple nepotism. At best, it’s a kind of spicy meritocracy, where VCs take the credit for realizing the value of talented techies. The tightly woven nature of the Northern California tech scene doesn’t go very far in explaining the rise of VC investing, but Mallaby seems enamored by what exactly set Silicon Valley apart—a common fixation among navel-gazing VCs. In truth, Mallaby’s inability to look outside of the “network” renders him blind to larger questions of economic power.

The only time when his network theory has any real explanatory power is when he’s describing the dot-com crash. “Because they are first and foremost networkers, it is costly for venture capitalists to even speak of a bubble. An investor who publicly questions a mania is spoiling the party for others,” Mallaby explains. But, moving on quickly, he proceeds to blame retail investors and the public stock market for not stepping up to complete their “disciplinary function,” effectively letting VCs off the hook for the responsibility of industry oversight that they’re meant to have carried out so graciously.

The dot-com bust may have ended in tears, but it was clear by that point that the impact made by VCs was irreversible. Mallaby’s VC hagiography posits these investors as quasi-regulators, supporting good governance, level-headed business practices, and responsible growth. This is because the start of VC investing depended on the idea that VCs would estimate a potential valuation for a company (not their actual value), and then invest a portion of that amount in a company in exchange for a certain amount of ownership shares. However contrived and inflated their valuations might be, the ownership stake led many VCs to take an active role in governing fledgling startups. We hear about how VCs come into Cisco and clean up the operation, cutting costs and ousting the husband-and-wife co-founder team.

Yet Mallaby readily admits that VCs frequently end up flailing when faced with the task of actually governing companies, Uber being a particularly useful case study in impotent VC intervention. So, what are VCs really good for? That’s the anxiety animating The Power Law. Over and over again, we see VCs presented in a bind, caught between being too loving or not loving enough. Are they meant to be hands-on coaches, or to drop in as mere consultants? Do they actually do anything, or are they just middlemen? John Doeer, a towering figure in the VC world, famously referred to himself as “a glorified recruiter.” It seems worth taking VCs at their word on this point.

It’s hard to deny that VCs have had an enormous hand in allocating capital—in Silicon Valley at least, they’ve essentially fulfilled the role of economic planner.

From Mallaby’s perspective, however, the best venture capitalists aren’t about crunching numbers, but about intuition, “emotional intelligence,” people skills, and—dare I say it—vibe.  And yet when they get hold of a company, their job is to be the adults in the room. The tension between these two guiding principles of VC investing can have disastrous outcomes. The VC funds that poured into WeWork kept the company from going public, meaning that it could continue to go back to VCs for further rounds of funding without the pressure of regulation and public shareholders. But as WeWork got increasingly chaotic internally, its investors found themselves trapped in a burning building, unable to get out and unable to exert any control in the boardroom.

As for the supposedly innovative business models that VCs fund, many of the largest payouts have come from rote replications of market formulas that have already been tried and tested. The “Uber of such-and-such industry” became a common refrain when explaining startups over the past decade, and Mallaby explains how Uber itself was a sort of replica of the much-less-inspiring restaurant reservation platform OpenTable. Tiger Global, the VC-cum-hedge fund that’s won the praises of the tech community for its far-flung investment locales, was particularly big on what they deemed “the-this-of-that” model, which suggests that tech investing is nothing if not uninspired.

What tends to unite VCs is not concern about the failures of companies like WeWork or Theranos (not to mention Quibi, Juicero, Moviepass, Jawbone, Chef’d, Pets.Com . . . the list goes on) but a fixation on missed opportunities. There’s always the proverbial one that got away—a lucrative deal that was foolishly declined, and thus destined to become a VC lesson, presented with an astounding amount of faux humility. The VC firm Kleiner-Perkins turned down Steve Jobs. Accell turned down Skype. Andreesen Horowitz invested only $250,000 in Instagram, then bet big on one of their failed competitors. Tiger Global reduced their Alibaba shares before it went big. Bessemer Venture Partners proudly flaunt an “Anti-Portfolio” of all the companies they missed out on.

All of this is part of VC mythmaking, which Malaby himself indulges in gleefully. As he tells us, “venture capitalists as a group have a positive effect on economies and societies.” When they win, it’s for systematic reasons, and when individual companies fail, it’s the individual investor’s fault. Regardless of which deals one VC or the other may have missed, other firms were ready to fork out the early stage capital needed to grow the platform economy. “Intelligent deal selection,” which Mallaby tells us “ensures that society’s savings are allocated productively,” is exactly what makes the stakes of VC investment so high. It’s hard to deny that VCs have had an enormous hand in allocating capital—in Silicon Valley at least, they’ve essentially fulfilled the role of economic planner.

Mallaby’s arc of venture capital goes something like this: at first, the VC model saw a period of slow adoption, before entering a period of rapid expansion, where money sloshed around freely, and then developing into a more competitive environment, where rivalry between tech companies became costly for VCs, who footed the bill for free rides and discounted grocery deliveries. More recently, in response to those outlays, venture capitalists have acted more explicitly as arbitrators: “They brokered takeovers, encouraged mergers, and steered entrepreneurs into areas that were not already swamped.” Power became concentrated, and the decisions of VCs became a kind of industrial policy, as they played what essentially was the role of a deeply undemocratic central government.

If the vast portfolios of VC firms imbue them with the powers of a state, then what kind of political project might they be shepherding? The business models most favored by VCs suggest it’s a project that opposes actual state regulation and promotes never-ending growth. The fact is, as Mallaby himself admits, that the vast majority of small businesses do not emerge with the immediate aim to monopolize a market in the way that startups do. VC funding is unique in that it is meant to propel a company toward exponential growth so that it can cut out competition, gain market control, and overpower regulators. Yahoo, backed by the mind-boggling large VC investments of Masayoshi Son (who would later found SoftBank), cornered the search market, helped develop online advertising as we know it, and consistently defied regulators by refusing to take responsibility for what appeared on their pages. That deferral of responsibility was codified in 1996, thanks to the infamous Section 230 of the Communications Decency Act. Amazon has achieved much the same result in the world of online retail, evading regulators and “disrupting” the market by insisting they aren’t liable for dangerous products sold through their site. If you were wondering what the pro-VC line on the problem of Big Tech monopolies would be, look no further than The Power Law. “The right answer to this problem is to regulate monopolies when they arise, not punish venture capital,” Mallaby argues. “After all, venture capital is all about disrupting entrenched corporate power: it is the enemy of monopoly.”

If the vast portfolios of VC firms imbue them with the powers of a state, then what kind of political project might they be shepherding?

Despite these assurances, the book paints a bleak future—one where control of our economic reality bounces from one monopoly to another, as one set of corporate overlords is replaced by another, ad infinitum. As Mallaby himself admits, companies like Yahoo, Google, and Uber don’t become monopolistic by accident. Yet the venture capital model is, according to him, “a theory of progress.” And not just that, it’s a theory of progress that we should all be embracing, if we haven’t already: “The venture capital approach of high-risk, high-reward experiments does represent a distinctive way of coming at the world, one that people outside Silicon Valley might learn from.”

Venture capital is unlikely to stop making outlandish investments any time soon. But it does seem that on a broader level, there’s change afoot. President Joe Biden’s CHIPS for America Act, a massive investment aimed at onshoring cutting-edge semiconductor manufacturing, is just one sign of an increasing appetite for ambitious industrial policy. Rather than leaving the allocation of capital to venture capitalists, the United States is looking toward China and state-driven innovation efforts, where massive public funding, tax breaks, and the heavy favoring of certain industries draws capital to exactly where the state intends it to go. And while low interest rates have pushed money into high-risk venture capital funds in recent years, the Fed’s move to push up rates may also draw money away from VCs. There have been several instances of quite serious tech sell-offs in equity markets over the last year or so, and a widespread decline in share prices suggest that the tech companies have been woefully over-valued.

For all his obsession with the big-picture complexities of the tech world, Mallaby tends to avoid the real impacts of the VC model. The Power Law espouses a contrarian liberalism (a mode that is likely familiar to those who follow the writings of VCs themselves) that enshrines the expert, the manager, and the invisible hand of the market. It’s a contrarianism that doubles down on venture capital at the very moment when many are raising alarm bells about its role in hyping up unviable companies and scammy founders. But even then, it isn’t the catastrophes that define the transformative significance of venture capital, but the companies tech investors tell us are the most resounding triumphs: Facebook, Apple, Google, Amazon, and the other behemoths who have come to recreate the modern world in their image by stripping away employment rights, cultivating economic dependency, holding enormous influence over politics and civic life, and fundamentally changing the way we relate to one another, whether we like it or not. And it may be these glowing successes, just as much as the dismal failures, that eventually spell the end of venture capital as we know it.